Insurance Law and Exclusion (m): It's Not Broken If You Can Fix It

November 2007

Some courts have observed recently that general liability policies will cover claims for property damage to the insured's completed work when the work was done on the insured's behalf by someone else. In doing so courts often consider the scope of exclusion (l), the "your work" exclusion.

by R. Steven Rawls and Rebecca Appelbaum
Butler Pappas Weihmuller Katz Craig, LLP

In modern general liability policies, the first part of exclusion (l) excludes coverage for the insured's work. The subsequent exception contained within the exclusion expressly nullifies the exclusion when the work was done on the insured's behalf by someone else. However, the effect of exclusion (l) does not extend to claims for nonconforming work that is not physically injured even when that work is done on the insured's behalf by someone else. Exclusion (m) will ordinarily bar such coverage.

Recently, Lamar Homes Inc v. Mid-Continent Casualty Co., 2007 WL 2459193 (Tex. 2007), extensively described the scope of exclusion (l) in the context of claims for property damage involving physically injury to tangible property. In Lamar, the court held that a claim for damage to the general contractor's work that alleged physical injury to tangible property constituted a claim alleging a covered "occurrence" under a commercial general liability (CGL) insurance policy.

The court explained that:

when a general contractor becomes liable for damage to the work performed by a subcontractor—or for damage to the general contractor's own work arising out of a subcontractor's work—the subcontractor exception preserves coverage that the "your-work" exclusion [exclusion (l)] would otherwise negate.

Lamar at 14. The court observed that, by amending the 1986 edition Insurance Services Office, Inc. (ISO), CGL form to include the exception to exclusion (l), the insurance industry agreed to cover a huge portion of faulty workmanship claims.¹

Importantly, Lamar and similar cases² involve physical injury to tangible property. These cases do not address whether a GL policy covers damages sought solely for nonconforming work done on the insured's behalf by someone else. Exclusion (m) precludes coverage for nonconforming work, and this is so regardless of whether the work is ongoing or completed, or performed by the named insured or a subcontractor.

The Policy Language

The standard ISO commercial general liability post-1986 policy form contains exclusion (m), commonly known as the impaired property exclusion. Exclusion (m) precludes coverage for "property damage" to "impaired property" or property that has not been physically injured, arising out of:

1. A defect, deficiency, inadequacy or dangerous condition in "your product" or "your work"; or

2. A delay or failure by you or anyone acting on your behalf to perform a contract or agreement in accordance with its terms.

This exclusion does not apply to the loss of use of other property arising out of sudden and accidental physical injury to "your product" or "your work" after it has been put to its intended use.

"Impaired property" is defined as tangible property, other than "your product" or "your work," that cannot be used or is less useful because:

1. It incorporates "your product" or "your work" that is known or thought to be defective, deficient, inadequate or dangerous; or
2. You have failed to fulfill the terms of a contract or agreement;

If such property can be restored to use by:

1. The repair, replacement, adjustment or removal of "your product" or "your work"; or
2. Your fulfilling the terms of the contract or agreement.

Exclusion (m)

Exclusion (m) is one of the business risk exclusions and "is intended to exclude coverage when the cause of loss is within the insured's control, such as the quality and conformity of the product." Washington Energy Co. v. Century Surety Co., 407 F. Supp. 2d 680, 690 (W.D. Pa. 2005). The sudden and accidental exception to the exclusion limits the effect of the exclusion to provide coverage for consequential damage to property other than that of the insured's, arising out of sudden and accidental physical injury to the insured's product (or work) after it has been put to its intended use. SeeNational Engineering & Contracting Co. v. U.S. Fidelity & Guaranty Co., 2004 WL 1103993, 8 (Ohio App. 2004).

The impaired property exclusion "narrows coverage for claims involving the reduced usefulness or impairment of property other than the insured's." Standard Fire Ins. Co. v. Chester-O'Donley & Associates, Inc., 972 S.W.2d 1 (Tenn. App. 1998). The Standard Fire court explained the effect of exclusion (m) "is to bar coverage for loss of use claims (1) when the loss was caused solely by the insured's failure to provide work of the quality or performance capabilities called for by the contract and (2) when there has been no physical injury to property other than the insured's work itself." Standard Fire at 10. According to the court:

[t]he exclusion does not apply if there is damage to property other than the insured's work ... or if the insured's work cannot be repaired or replaced without causing physical injury to other property." Id. (citations omitted).

Impaired Property or Property Not Physically Injured

Exclusion (m) applies to property not physically injured or to "impaired property." Insurers typically include this exclusion in a policy to prevent the insured from claiming economic losses resulting from the insured's work or work product. Pinkerton & Laws, Inc. v. Royal Ins. Co. of Am., 227 F. Supp. 2d 1348, 1354 (N.D. Ga. 2002). In North Am. Treatment Sys., Inc. v. Scottsdale Ins. Co., 943 So. 2d 429 (La. App. 2006), the court explained that exclusion (m):

excludes coverage for damage to property that has not been physically injured or for which only loss of use is sought. ... However, the exclusion does not apply where there is physical damage to property other than the insured's work or product.

North American Treatment Systems at 445. The scope of exclusion (m) regarding "impaired property" sometimes appears to turn on whether the "impaired property" can be restored to use.

Courts discussing the effect of such restoration include Dorchester Mut. Fire Ins. Co. v. First Kostas Corp., Inc., 731 N.E.2d 569 (Mass. Ct. App. 2000). In this case, homeowners sought damages when painters hired to paint the exterior of the house caused lead paint chips and dust to infiltrate the interior of the home. In finding that exclusion (m) precluded coverage under the painter's CGL policy, the court explained that the painters alleged failure to contain the toxins set free during the scraping and sanding operations was:

certainly an inadequacy and a dangerous condition in their work ... [which] denied the owners the use of their house until it could be restored to use by the removal of the faulty element of the contractor's work, the errant chips and dust.

Dorchester at 572.

In Wayne Brothers, Inc. v. North River Ins. Co., 2003 WL 22213615 (M.D.N.C. 2003), the court, considering a motion for summary judgment, explained that the insurer did not meet its burden of proving exclusion (m) applied to preclude coverage because the insurer did not demonstrate that "merely repairing, replacing, adjusting or removing" the insured's work "(or [the insured's] fulfillment of its contractual obligations)" would restore the claimant's "impaired property" to its intended use. Wayne Brothers at 8. The damages alleged could not be remedied by the repair of the insured's work.³

The Sudden and Accidental Exception

Exclusion (m) however, contains an exception which applies only if there is "sudden and accidental" injury to the insured's product or insured's work. Courts have extensively litigated the phrase "sudden and accidental." Courts often find this phrase ambiguous, resulting in coverage pursuant to the exception to exclusion (m). Liberty Mut. Ins. Co. v. Wheelwright Trucking Co., Inc., 851 So. 2d 466, 496 (Ala. 2002).⁴ The court in Hartzell Ind., Inc. v. Federal Ins. Co., 168 F. Supp. 2d 789 (S.D. Ohio 2001), infra, found "sudden and accidental" unambiguous. Hartzell at 799. This phrase included both a temporal and unexpected component, each of which were satisfied by the facts of the case so that the CGL policy afforded coverage. SeeHartzell at 800.

In Hartzell, Federal insured Hartzell under a CGL policy. Hartzell provided the Allegheny Power Company with seven roof fans to cool its boiler house. The propellers on one fan disintegrated and Hartzell provided Allegheny with replacement propellers for all seven fans. Subsequently, the propellers on the same fan unit disintegrated a second time and Allegheny shut down all seven fans. Allegheny sued Hartzell who sought a defense and indemnification from Federal.

The court found that Allegheny stated a claim for damage to its own property. Allegheny's boiler house was less useful because "worker productivity declined due to the extreme heat inside the building." Hartzell at 798. Because the claim was for (loss of use) damage to Allegheny's own property, the boiler house was clearly "impaired property," as defined by the policy, and also clearly fit within the impaired property exclusion. The court explained that

the boiler house became less useful to Allegheny ... because it incorporated Hartzell's fan, but ... could have regained its full usefulness if Hartzell's defective fan had been repaired or replaced .... Although its facility was not physically injured, Allegheny experienced ... a partial loss of use of its boiler house arising from an alleged defect ... in Hartzell's fan, which disintegrated.

Id. at 799.

The court held that the exception to exclusion (m) applied to negate the effect of the exclusion, explaining that:

if the insured's product is put to use and then is suddenly and accidentally injured causing injury to other property, the injury to the other is within the coverage of the insurance policy.

Id. at 800. In finding coverage, the court explained that if Hartzell's fan had simply failed to work as warranted by failing to cool the building, coverage would be precluded even if the heat lead to less worker productivity but, because the fan propeller suddenly and accidentally disintegrated, the exception applied and Allegheny's loss of use of the boiler house was covered. See id.

Exclusion (m) Sometimes Trumps Exclusion (l)

Mid-Continent Cas. Co. v. Camaley Energy Co., Inc., 364 F. Supp. 2d 600 (N.D. Tex. 2005), illustrates how the trend in interpreting exclusion (l) may not automatically require the insurer to pay for faulty completed work even if it was performed by subcontractors. In that case, Mid-Continent provided Camaley a defense under a reservation of rights against a lawsuit alleging that Camaley, while drilling a well, deviated from the plotted well bore resulting in:

trespass into the neighboring leasehold which resulted in the constructive eviction of the [underlying plaintiff] from its leasehold and use of enjoyment of same.

Camaley at 602. Mid-Continent sought a declaration that it had no duty to defend and sought summary judgment arguing that the underlying complaint failed to allege an "occurrence," failed to allege "property damage" and exclusions (j)(5), (l), and (m) precluded coverage.

The court held that the underlying plaintiffs alleged an "occurrence" because they alleged an "accidental deviation" from the plotted well bore. Because the plaintiffs alleged that they were "constructively 'evicted' from their leasehold," the court held that "these damages appear to be covered 'loss of use of tangible property' and not purely economic damages," which would not constitute property damages. Thus, the allegations of the complaint fell within the insuring agreement.

The court then turned to the CGL policy's exclusions. The court applied exclusion j(5) and exclusion (m) to determine that Mid-Continent had no duty to defend the insured. The court held that j(5) excluded the insured's negligent conduct from coverage because the insured's negligence while drilling (during the insured's drilling operations) "caused the alleged property damage." Importantly, the court determined that, while the complaint was vague as to whether subcontractors performed the work "it must be read liberally in favor of the insured," and that, in consequence, exclusion (l) would not apply because exclusion (l) did not apply to work performed by subcontractors. However, the court applied exclusion (m) to preclude coverage because the leasehold at issue was "property that has not been physically injured" and the damage alleged was caused by the insured's negligent drilling. The negligent drilling constitutes either "a defect, deficiency, inadequacy, dangerous condition in [the insured's work]" or, the bore deviation constitutes the insured's "failure to perform their work ... in accordance with the contract." Id. at 608.

Conclusion

Camaley illustrates the importance of reading the policy as a whole. While Camaley considered the scope of exclusion (l), the "your work" exclusion, the court found that exclusion (m) nonetheless applied to the claims there. This is consistent with the notion that the effect of exclusion (l) does not extend to claims for nonconforming work that is not physically injured even when that work is done on the insured's behalf by someone else. Exclusion (m) will prevent the insurer from having to pay for nonconforming work even if it was performed by subcontractors.

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Contributing author Rebecca C. Appelbaum is a senior associate practicing in the area of third-party coverage at the firm of Butler Pappas Weihmuller Katz Craig, LLP.

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¹Coverage for these faulty workmanship claims can be eliminated by adding ISO endorsement CG 22 94 10 01, which eliminates the exception to exclusion (l) but preserves the remainder of the "your work" exclusion.

²See alsoJ.S.U.B., Inc. v. U.S. Fire Ins. Co., 906 So. 2d 303 (Fla. 2d D.C.A. 2005), rev. granted, 925 So. 2d 1032 (Fla. 2006).

³See alsoFederated Mutual Ins. Co. v. Grapevine Excavators, Inc., 197 F.3d 720 (5th Cir. 1999) (finding exclusion (m) did not apply to preclude coverage where there was no evidence that the damaged work could be restored to use by the repair, replacement or removal of the insured's work).

⁴Contra Dimmitt Chevrolet, Inc., v. Southeastern Fidelity Ins. Co., 636 So. 2d 700 (Fla. 1993) (holding sudden to include a temporal aspect and "sudden and accidental" to be unambiguous in the context of a pollution exclusion).

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